A time capsule of the greatest financial mania in the history of mankind, told in real-time by regular folks and patriots. May future generations better understand the madness of crowds, and how power and money corrupt.

April 06, 2007

During this period of dis-credit, or "The Great Unwinding" as I like to call it, people rush to sell their assets, de-risk, and get to cash. This stage is FIRMLY underway when it comes to houses in the United States. But that's just the start my friends. Asset price deflation will now happen worldwide, and not just with houses.It will happen with everything.Stocks. Metals. Houses. Condos. Baseball Cards. Artwork. Stamps. Everything.Want a safe haven? Good luck. There are none, except cash. Just read the book. And this is a pretty damn good article too, I found it tough to cut anything out - click the link and read the whole thing...

Asset Price Deflation: The New Rules of Real Estate

When it comes to selling your real estate, better a year too soon than a day too late. As real estate values deflate in the U.S., it is clear that different markets will take their lumps at different times, much the same way dot.com stocks bit the dust one at a time when the NASDAQ collapsed in 2000. Some areas will buck the trend and hold up better than others. But scattered markets throughout the U.S. have already experienced the onset of real estate deflation, more communities are faced with that reality each day, and the psychology is getting damaged beyond repair.

Peoria's problem is your problem as lenders pull back (or go bankrupt), homebuilders decline to offer earnings guidance, and the mainstream media convey the news of the spreading disease.

Investment manias have always ended in deflationary depressions and we have just concluded the two grandest investment manias of all time, piled one on top of the other.

If you are buying real estate to hold right now, you could lose your equity and ultimately your property. At the very least, you should be taking a wait-and-see approach to buying at this point. The risk/reward ratio is completely out of whack and the snowball is just beginning to form, just a few hundred feet from the top of this enormous and steep mountain. If you can't see the danger and are buying property, face it -- you could pay dearly.

If you are counting on the Federal Reserve to "inflate" in order to save real estate's bacon, I believe you are making a mistake. The market will be taking it from here and the Fed will be powerless to "fix the problem." Socionomist Robert R. Prechter, Jr. (author of the recommended Conquer the Crash , 2002 ) in my opinion says it best.

The psychological aspect of deflation and depression cannot be overstated. When the social mood trend changes from optimism to pessimism, creditors, debtors, producers and consumers change their primary orientation from expansion to conservation . As creditors become more conservative, they slow their lending. As debtors and potential debtors become more conservative, they borrow less or not at all. As producers become more conservative, they reduce expansion plans. As consumers become more conservative, they save more and spend less. These behaviors reduce the "velocity of money," i.e., the speed with which (money) circulates to make purchases, thus putting downside pressure on prices. These forces reverse the former trend...

If people and corporations are unwilling to borrow and unable to finance debt, and if banks and investors are disinclined to lend, central banks cannot force them to do so. During deflation, they cannot even induce them to do so with a zero interest rate.

Thus, regardless of assertions to the contrary, the Fed's purported "control" of borrowing, lending and interest rates ultimately depends upon an accommodating market psychology and cannot be set by decree. So ultimately, the Fed does not control either interest rates or the total supply of credit; the market does...

Default and fear of default exacerbate the new trend in psychology, which in turn causes creditors to reduce lending further. A downward "spiral" begins, feeding on pessimism just as the previous boom fed on optimism. The resulting cascade of debt liquidation is a deflationary crash. Debts are retired by paying them off, "restructuring" or default...

In desperately trying to raise cash to pay off loans, borrowers bring all kinds of assets to market, including stocks, bonds, commodities and real estate, causing their prices to plummet. The process ends only after the supply of credit falls to a level at which it is collateralized acceptably to the surviving creditors.

People in communities across America are walking away from their upside down, nothing-down mortgages as the housing mania unwinds. Homebuilders are giving buyers $30,000 to $50,000, even $70,000 worth of free upgrades, credits and "incentives" while still reporting the sale at full (or gross) price. Back-to-market foreclosure properties are adding to the slump, while bankruptcies in the U.S. are up 70% year over year. There are significantly fewer buyers, and those buyers are offering less. I would not be surprised if many (not all) U.S. real estate markets have already experienced 20% market declines in the most recent 18 month period.

Additionally, the number of sales is down considerably -- in many markets 30% to 40% -- so the number of people willing to buy for just-beyond-peak prices has already dropped substantially.

Themarket is in the process of going splat, buyers are noticing and getting skittish, the mainstream media coverage is reinforcing the psychology and the foreclosure/lending/ banking crisis has just begun. The challenges we face from the real estate shakeout become more daunting each day.

Don't leverage into anything. During the credit contraction/liquidity crisis portion of the post-bubble meltdown, anyone who is leveraged will get punished. So do not borrow against one property to buy another, do not buy with little or nothing down, do not use your line of credit to buy real estate, and do not take on a teaser or negative-amortization loan betting on market appreciation going forward. Look at everything with the most critical eye you can muster right now. In fact, resist your urge to use leverage to buy any investment, including stocks and precious metals. All asset categories will fall together in the coming deflationary environment -- at least for a time. The term "leverage" should become passé for quite a while.

If you buy now, there may be few or no willing buyers when you decide to sell (or are forced to sell). I know this is difficult to imagine after 70 years of real estate appreciation, but the last time the United States experienced a post-bubble, deflationary depression (1929-1933), real estate fell almost completely out of favor and property values fell precipitously. Unfortunately, because of the bigger bubble, I expect things to be even worse this time.

When a liquid asset (like a stock) loses value, you can still sell it, albeit for a loss; real estate is not liquid, so if that market "crashes," you are not able to simply call a broker and sell it immediately. You may find a damaged buying psychology and no buying interest, and find yourself faced with the difficult choice of taking a loss each month or walking away from your investment.

Alas, the rules of the game are changing. I know it will require an adjustment in thinking and old-school budgeting, but if you plan to keep your home and are fortunate enough to still have substantial equity, you must make the decision to live within your means. Pay down debt wherever you can. Work to pay down your equityline, do not use your home mortgage any longer to "consolidate your bills," close that preposterous checking account which automatically adds to the balance of your home loan. Implement a tight and disciplined budget. Become lean and mean. Take at least 10% of your paycheck and tuck it away safely for savings. Safe cash will be king in the coming environment and you'll be able to use that money to make money.

Do not listen to the National Association of Realtors, the CEO's of Coldwell Banker Real Estate, Countrywide Financial Corporation, or anyone else in the industry whose livelihood depends on your willingness to place at-risk your hard-earned money.

Friends, listening to what these folks have to say is akin to walking into a car dealership and asking the salesman if today would be a good day to buy a car.

I have been in the investment real estate business for 25 years and the N.A.R. has never taken any position other than, "Now is the best time to buy real estate!" They proclaim it in up markets, down markets, sideways markets, active markets, dead markets, high interest-rate markets, low interest-rate markets and this-little-piggy-went-to-the-market markets.

Be ready for the propaganda. Industry people will look you in the eye and maintain that "there is no real estate bubble." They'll goad you by saying that "it's a buyer's market." They'll say that "real estate values in the United States always go up in the long run," (unfortunately, to them, "always" means since 1932. Real estate values collapsed in the U.S. after the Stock Market Crash of 1929 and also dropped an average of 70% over 16 years' time in Japan's very recent post-Nikkei bubble real estate deflation).

The pimps will tell you authoritatively that the last time we had a downturn in the real estate market, it only lasted a few years at which point values took off again. (And they're right; 1990-1993 saw real estate values drop in the U.S. before the glorious run-up began. The problem is, this time it is a post-NASDAQ bubble, post-real estate and mortgage bubble-bubble long-term deflation situation, not a normal real estate down cycle).

Eventually, they'll tell you with great conviction that "we've reached the bottom" and they'll continue to do so year after year after year forever and ever, Amen.

Some folks sold their NASDAQ stocks at the top of the curve in January of 2000; they were the ones who protected their assets and won the first game of the Asset Preservation World Series.

55 comments:

Here's my question: if 'cash is king', but the US Dollar is tanking, what's the solution? Foreign currency? But if the bubble is worldwide, will it help?

Any suggestions for strong foreign currency appreciated. Or other strategies? Metals?

Also, I am 24, have 0 current debt, and am about to begin law school and take out 90,000 in loans. I'm scared ****less as you might imagine. As I understand it, if we see inflation, I'm in good shape because 100k in 2010 US Dollars will be much easier to pay back. But what if there's deflation?

Cash is king in a deflationary depression....but what kind of cash? Short term UST bonds held in the safest institutions (some money markets are backed by short term, "high quality" US debt), foreign cash and bonds (the merk fund is a good way to do this), and in my opinion, the ultimate foreign currencies....silver and gold. Yes, they may lose value during the deflationary period....but as Bob Prechter says..."It may be different this time". I'm about 1/5 metals, 4/5 cash right now, and I can sleep at night.

As for law school? I say do it. Remember, a deflationary crash won't last forever. By the time your done with school, our gov't will have begun the most devastating series of fiscal and monetary mistakes in our history....leading to an inflationary spiral that will make the roaring 2000's look tame. See yen carry trade for details.

cash is king, losing value to the feds bogus inflation numbers that does not include housing ownership cost, only the modified owners equivalent rent, or/and then over the years since the change in the methods of calculation, it may be as high as 14% a year compounding, thus the dollars true value, planned and conspired against savers, the pasts way to strength and U.S greatness>

Inflation on anything you buy like food, fuel, taxes etc are inflating at over 10% a year.Your savings drawing 6% a year minus taxes are losing buying power year after year.

Central banks throughout the world (not just the fed) are printing money like a man possessed, once the bombs start falling on the middle east (and they will) watch the price of oil skyrocket. See how much Chilean merlot, south African kiwi fruit, and plastic Chinese crap they import halfway round the world with oil at $200 a barrel!! Think it can't happen, ask yourself what you think a blockade of the Straits of Hormuz will have on the oil price. Last week the oil price jumped 8% in minutes on an unsubstantiated rumour of an attack on Iran.

I bought silver at $5 and gold at $300, and my money's staying there too.

I say get the law degree: the class-action lawsuits stemming from the widespread unregulated corruption will be plentiful! Professionals (doctors, dentists, lawyers, etc) have always done good during turbulent times, as people still need these basic services. This will be a BOOM TIME for your profession.

No, the guy who's going to be sweating is the uneducated individual who's dependent on others for his job (W-2 earner).

I'm just not sure about this inflation v. deflation thing. That's the big variable in all of this.

The articles author argues that the fed will act as it did in the 1930s and raise interest rates to protect the dollar. But I believe Bernanke himself has identified that policy as a misguided one and a significant contributor to the length and depth of the 1930s depression.

Also, with the current account deficit so high, won't foreign banks look to other currencies and therefore keep the market for USD flush with supply?

I believe there is a housing bubble but I just don't know how it will all shake out.

As for the '1-L', I say go for it. There are electives in Bankruptcy law and real estate - this may not be cheerful work but it will be in high demand and lucrative. Either that or Intellectual Property - technological innovation will continue, albeit at a slower pace, even with reduced investment all around.

Tons of stuff and furniture on Craig's List for sale. Most of all... covented Pottery Barn furniture. Folks just had to have that $700 faux coffee table... too bad, now it's worth way less than half of what they paid for it.

A lot of not too bright folks here that somehow think we are headed for inflation. Why do people love inflation so much? I'll never understand it.

Even without the manias we are in a deflationary environment. The inflation of the past five years was all Central Bank induced (plus war spending, tax cuts ...) The patient is rather hyped up on uppers and Starbucks latte's at the moment. Naturally the Feds of the world will lower rates to the floor again, but pushing on a string ...

US Treasury bonds should do very well as both the market and the Fed push interest rates down.

Hyperinflation first, then deflation. Save money in silver & gold. The dollar is going down hard but it will not save real estate. Real estate will still come down dramatically as the dollar falls. Food, energy and your basic costs of getting by will continue to increase.

"I am 24, have 0 current debt, and am about to begin law school and take out 90,000 in loans."

Law school sucks my friend and is nothing but a racket. Some states, including NY, allow you to sit for the bar by serving under an attorney as an apprentice. If I had to do it again, this is how I would try to do it, but then again, it would be hard to find an attorney willing to do it and you would essentially be someone's bitch for about 4 years.

Also, if you are going to go to law school, make sure you go to a well-known school as a well-known school, while it might not be as good academically, is better when you go looking for a job than the lesser know, but better, school.

Also, see if an employer will pay for you, or, if you work for a federal agency, such as the USPTO, see if they will assist with tuition.

I currently have about 60K in loans and will not pay it off for another 20-25 years. While I, arguably, could pay it off in 10, I would have absolutely no life whatsoever.

Yeah, you can get a high paying position, but just remember, they're called "golden handcuffs" for a reason.

If it were so obvious everyone with a brain would just go to cash. I think it's more like this.

It's a teeter todder:On one hand, the fed can reflate (print money), kill the dollar, pay off the debt with monopoly money and start again with a new currency after TSHTF (get in debt, hold gold and land with no crap houses on it, get a small energy efficient house with a fireplace)In this scenario the morons in debt get saved and vote for the president who bailed them out, US loses world currency holder status, no more imports from china, and many decades of hard living in US with a new local manufacturing industry.

---OR---

The fed tries to save the dollar, a la Volkler, then you pay off debt or get fixed rate long rates and hunker down while everybody else goes bankrupt.

The trouble with scenario B is the foreign debt, that's why I think scenario A is what will happen. The real curveball will come from China. I predict they will buy up mucho US real estate with their cash when the market hits bottom.

Either way it's more than the real estate pimps who end up rioting for ramen noodles in the near-empty grocery stores.

However it goes, have stuff with real value. Learn real skills, and make real friends who live close to you.

Also, I am 24, have 0 current debt, and am about to begin law school and take out 90,000 in loans. I'm scared ****less as you might imagine. As I understand it, if we see inflation, I'm in good shape because 100k in 2010 US Dollars will be much easier to pay back. But what if there's deflation? Should I even consider postponing law school on the basis of this? _______________________

The State of Washington has the Rule 6 Law Clerk program, whereby a person can apprentice himself to a working attorney for a few years and become a legal, bar-registered attorney without going to law school. Perhaps your state bar association has the same program.

Also, I am 24, have 0 current debt, and am about to begin law school and take out 90,000 in loans. I'm scared ****less as you might imagine. As I understand it, if we see inflation, I'm in good shape because 100k in 2010 US Dollars will be much easier to pay back. But what if there's deflation? Should I even consider postponing law school on the basis of this? ____________________

Also, don't forget the alternative of continuing your day job and going to law school at night. It may take a year or two longer, but you won't have to take out as many loans. I worked three-quarter time through both my Master's degrees and took out no loans at all.

Look at Everbank, and consider parking your money in Japanese Yen. Their currency is undervalued because their interest rates are so low. As the dollar declines and the Japanese economy finally heats up, the Japanese will raise interest rates and their currency will rise relative to ours.

The articles author argues that the fed will act as it did in the 1930s and raise interest rates to protect the dollar. But I believe Bernanke himself has identified that policy as a misguided one and a significant contributor to the length and depth of the 1930s depression.________________

I'm sure the Fed has watched what has happened in Japan over the last 15 years very carefully. No doubt the Fed will also drop the interest rate to zero and pray the bottom doesn't fall out of the value of the dollar leading to hyperinflation. This was the same bet the Japanese made with the yen--and won. Whether the dollar will meet the same kind of fate as the world's reserve currency is anybody's guess....

In deflationary times, a net debtor loses, since he has to pay off his debt in ever more valuable dollars.

FYI I am an economist, and two of my partners went to law school. I was tempted to do the same thing, but I agree with Keith: Cash will be king, and I'd rather have the cash than another degree that has only a very dubious chance of paying for itself when the credit market crashes and takes the economy with it.

Even before the collapse (or, if you prefer, "slide,") hits, our cities have become nasty, third-world slums and the educated people are fleeing them. Life in the U.S. will become increasingly unpleasent for all but the elite, and I think it's better to have cash to face the coming days, since cash will buy you options, whereas debt will buy you more and more misery.

Investing $100K in a law degree is an investment in the American economy; your degree won't do you much, if any, good in Japan, Korea, or any of the other places that are the rising stars. The smart money, my friend, is leaving the U.S.

Hello I have a question, please give me some advice. My mother has a house in a neighborhood that appreciated greatly in the last few years. She then took out 25% of her equity on a fixed rate. However, I know the price of this house will fall badly. This neighborhood has already fallen about 25 percent from the boom years. I worry that the 25% equity will soon become 100% equity or even in the negative. I want to know, should she give the money back? Is that possible, or should she just keep the cash and sit on it? I also would like to know what happens if you have negative equity but still have a loan?

Hi, this is the future law student again. Thank you all for your advice. I'm going to a quite well-known 'Top 40'. Since my major areas of interest are criminal and constitutional law - not exactly corporate level salaries for the most part - I have a bit of additional concern.

The tuition racket is possibly an even bigger racket than housing. Many students will graduate from fourth rate law schools $120,000 in debt - plus undergrad debt - with limited job prospects.

But still I feel I have to view it as a long term investment in my salary, overall quality of life and professional self-esteem.

So, for the limited liquid assets I have: are any foreign currencies better poised to weather the fallout? Canada (who are actually paying down nat. debt)? GBP? Euro? New Zealand Dollar? Yen?

'Thus, regardless of assertions to the contrary, the Fed's purported "control" of borrowing, lending and interest rates ultimately depends upon an accommodating market psychology and cannot be set by decree. So ultimately, the Fed does not control either interest rates or the total supply of credit; the market does...'

Well, Well, Well,Keefer, I’m the one that has been reminding you all (several times here) that Greenspan clearly stated that the RealEstate frenzy is a ‘Conundrum’.(Basically not understanding why when he raised short term interest rates, long term mortgage rates did not follow)

The RealEstate Bubble was caused by our human herd mentality.And the RealEstate Bust is being caused by our human herd mentality

Honica Jewinski, you might want to inform your buddy David Duke to remove the entire Greenspan section from his next little hate book, now that this blog formally posted.‘So ultimately, the Fed does not control either interest rates or the total supply of credit; the market does...'

BTW, my mom's house would have been paid for in 5 years. So she already had a lot of equity, and she pulled it out for a good reason and has spent some of the money but she spent it on repairs for the house which in 100 years had never been renovated.

April 4th, 2007With stunning views, abundant trees and manmade lakes, there’s hardly a prettier place in North Texas than Lake Ridge. On the southwest edge of Cedar Hill, the development’s custom homes on oversized lots make a clear statement of prosperity.

Canada: paying down debt, some of the world's largest proven reserves of non-traditional oil. But on the downside, our economy is based on selling raw materials and finished goods to the US, or raw materials to the Chinese to sell to the US...

Mixed advice here. If you are yearning to do law then do it. It depends on you want to do. Do bear in mind that as a lawyer (unless you are in the top .000001 percent) you will be place bound. Also there are no shortage of lawyers in the u.s. If you are not from a top 20 law school you will at best work in second tier regional firm. Good living, but the mean is driven up by the top law school grads at the top firms--again only a small percentage of all lawyers. To me (and I worked w lawyers) having skills that are good around the world has been golden. A PhD in Finance, Economics, MIS will serve you far better than a law degree....Plus as a grad student you get paid to go to school--be a TA.

Law student - if you handle things right, you'll make it. According to The Millionaire Next Door, docs and lawyers are the most likely professions for "high earner low net worth" because they buy into the notion that they must live a lavish lifestyle. With all due respect, could be the reason they chose their particular rackets (my doctor just billed $125 for dispensing antibiotics for a cold - har-har!) Also note - I was dating someone who completed law school, but became disillusioned. Now she's a dog walker. With way over that $120,000 debt mentioned above. Two years out, she's taking the bar, but can't stomach becoming a lawyer. So...whatever you do - stick with it at least until you can pay off that monster loan. I'm the son of a professor who felt the country is degree-heavy, and that undergraduate education should not be "vocational training" (again - this wouldn't apply to med/law school, but still). At some point, youngsters starting out might ask "why not buy a McDonald's or learn a trade instead of college?" and go later. You're ready and this is the time in your life you can make something of yourself. Life is not risk-free. Yes. Do it. Go. But keep informed. Use those same brains that stand you so well in school and laugh at the Joneses.

"Cash is king" huh? That sure worked well in Weimar Germany and John Law's France, didn't it? Without inflating the money supply, how will the US pay off the debts incurred for war, Social Security and Medicare? With estimates in the neighborhood of $40 to $50 trillion in unbooked liabilities for just these two programs, what about those estimates, if true, inspire confidence in the US dollar? With trillions more in debt to foreign investors, why should someone be confident in the future of the US dollar?

Some folks may be confident in the promissory IOU's of a bankrupt borrower. I don't happen to be one of them.

The Fed and the free-spending Congress will destroy the dollar to prevent a severe recession or depression. Cash is trash. Gold and other commodities are your safe haven. Stocks may hold up well, relative to the dollar, at least.

'Thus, regardless of assertions to the contrary, the Fed's purported "control" of borrowing, lending and interest rates ultimately depends upon an accommodating market psychology and cannot be set by decree. So ultimately, the Fed does not control either interest rates or the total supply of credit; the market does...'

Well, Well, Well,Keefer, I’m the one that has been reminding you all (several times here) that Greenspan clearly stated that the RealEstate frenzy is a ‘Conundrum’.(Basically not understanding why when he raised short term interest rates, long term mortgage rates did not follow)

The RealEstate Bubble was caused by our human herd mentality.And the RealEstate Bust is being caused by our human herd mentality

So if someone wanted to have children in the next 3-4 years, but was currently living in an one-bedroom apartment, what's the best move? House prices have almost doubled in this area in the past decade and sellers are keeping their houses on the market rather than lowering prices.

The articles author argues that the fed will act as it did in the 1930s and raise interest rates to protect the dollar. But I believe Bernanke himself has identified that policy as a misguided one and a significant contributor to the length and depth of the 1930s depression.--

The Fed can't do that for the next 3-5 years untill all the ARMs are straitened out.

On the flip side, there are only so many more nuke plants the US can give China to appease them to keep the crappy dollars...

First will come deflation as credit tightens and incomes have not kept up with rising prices. That will be followed by hyperinflation as the Fed lowers rates to .25% and does helicopter drops to stop the deflation. The US$, like the rest of the country, will become more "Mexican"

We could have rich Mexicans coming here to retire with their stronger Pesos

US currency will drop. Invest in gold and silver and precious metals. Merk hard currency fund is a good hedge. Bonds are not a terrible way to go either but the problem with bonds is you just barely keep pace with inflation. Stay away from high yield junk bonds. Oil and gas are good long plays. Energy demand in liquid fuels will begin to outstrip supply probably starting this year. Good luck.